Your company needs $100 Million for expansion and decides to issue a 5-year conv
ID: 2789851 • Letter: Y
Question
Your company needs $100 Million for expansion and decides to issue a 5-year convertible bond. The stock price currently is $41.67 and your banker recommends a 20% conversion premium. The total option value of the convertible will be $92.22 per $1,000 face amount of bond. The company's current cost of 5-year debt is 3% assuming semi-annual interest payments.
What should be the annual coupon of the convertible bond assuming you want the bond to trade at par? The coupon will be paid semi-annually.
How many shares will each $1,000 bond convert?
What is the return for an investor if the stock price in 5 years is 60?
Explanation / Answer
1. Calculation of coupon rate:
The current cost of debt to the company is yield to maturity on the bond. Since it is given that bond will trade at par, this implies that the coupon rate is equal to the yield to maturity. So, the coupon rate on the said convertible bond is 3%
2. Calculation of conversion ratio:
Conversion price of a share = 41.67 + 20% of 41.67 = 50
No. of shares ro convert the bond = Face Value of Bond/Conversion price of share
= 1000/50 = 20 shares
3. Return of Investor
Return = (Conversion Value - Par Value)/Par Value
= (20*60 - 1,000)/1,000
=200/1000 = .20
Return to investor = 20%
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